In late January, Fidelity Investments announced two specific actions they would take regarding their business relationship with Vanguard.
Fidelity indicated that effective February 1, 2018 they would no longer share revenue with Vanguard on Fidelity funds for all plans record-kept by Vanguard. Revenue sharing is when a portion of the expense ratio of the fund is credited to an outside vendor.
Fidelity will implement a 5 basis-point administration fee on all Vanguard funds used in newly acquired plans record-kept by Fidelity with assets of $20 million or less. This fee would be paid by Plan Sponsors.
The first action had immediate implications for Vanguard recordkept plans. Vanguard clients holding Fidelity funds were forced to assess the economics of their retirement programs to determine whether sufficient revenue was being generated by the remaining fund options in the plan to cover recordkeeping costs. If the analysis showed a shortfall, the client would need to decide how to cover the gap by selecting another fund that will cover the revenue shortfall or by compensating Vanguard in some other manner.
The second action has limited reach because it only impacts new business for Fidelity; and only newly acquired plans with less than $20 million in assets. However, it is still meaningful because we normally do not see additional fees and tactics targeted at one specific provider the way that is being done here. In this case the motives may be two-fold.
First, Vanguard has taken a dominant position in the marketplace for index and target date funds. Target date funds, which are often used as the Qualified Default Investment Alternative (QDIA) in plans, have garnered a substantial percentage of new contributions into defined contribution plans because of automatic enrollment. As a result, there may be a significant imbalance in the percentage of assets flowing into Vanguard funds on the Fidelity recordkeeping platform versus the volume of assets flowing into Fidelity funds on the Vanguard platform.
Additionally, Fidelity noted that Vanguard funds present certain unique operational challenges that other funds companies do not. Specifically, Vanguard requires firms to notify them by 3PM of trade activity within their funds. This can lead to earlier cutoff times and additional work required by outside vendors such as Fidelity.
Vanguard and Fidelity are recognized as strong competitors within the retirement industry. Fidelity has expressed frustration over the years that Vanguard is the only major fund provider that does not offer to share any of the revenue that they receive on their funds that are record-kept on the Fidelity platform. Vanguard’s position is that due to their unique ownership structure of being owned by shareholders and always trying to lower costs; they do not have the discretion to share revenue with any other firm. The perception from the marketplace is that they are acting as unpaid salespeople for Vanguard funds. In response to this belief, as an example, last year Morgan Stanley instructed all its brokers to stop selling Vanguard funds.
These announcements are not without controversy. Vanguard has stated they did not know that Fidelity was going to implement the announced changes. While, Fidelity’s position is that they had been engaged in negotiations with Vanguard on these points for a long period of time and that after a breakdown in negotiations they implemented the new policies. However, Vanguard stated that they had no notice that changes were coming and that they learned about the policy changes through the media at the same time as the public at large; not directly from Fidelity.
It is unclear at this time whether other recordkeepers will follow in Fidelity’s footsteps and how this could potentially effect competition within the industry. PEI will continue to stay abreast of any further developments and will keep our clients informed.